"A child's learning is the function more of the characteristics of his classmates than those of the teacher." James Coleman, 1972

Monday, November 23, 2009

"Dead Peasant" Policies, Life Settlements, and Other Evils of Capitalism

I saw Capitalism: A Love Story over the weekend and came away with another layer of understanding of how our former love, with whom we invested so much trust and care throughout our long affair, turned out be the incarnation of evil and generally oppressive despot, despite all of our best efforts to make it work.

So, yes, Virginia, there is still a Santa Claus, but he is not coming to your house anymore unless you are in the top 1 percent of Americans (See chart above, and click it to enlarge: From Center of Policy and Budget Priorities). If you are so lucky as to be in the top 1 percent, Santa needs to remember to have the doorman bring right up all those Neiman-Marcus items you ordered online. Otherwise, they may be taken by the hungry crowds in the street who are starting to circle your building.

Now if you are one of these hungry ones, looking for a job or another job to help keep food on the table or a roof above your head, you probably can't afford the 10 bucks to see Michael Moore's movie. So here is something you might want to check out. When you go to the public library, if you still have one that is still open, to print out your resume and application letters, go to this site to see if your employer or your past employer has a "dead peasant" policy on you. It is a death hedge, you might say, one that is tax-deductible for your employer, and if you happen to starve to death or die of a stroke, then your employer collects. Check out the hundreds of corporations that buy "dead peasant" policies on their peasants, er, employees.

There are many real life capitalist horrors that Moore's researchers missed or could not include. My favorite of late is a new investment scheme known as life settlements, an arrangement whereby investors buy up life insurance policies at a discount, bundle them into packages, and sell them to other investors who collect when the original insureds die. The New York Times explains (and this is no joke):

After the mortgage business imploded last year, Wall Street investment banks began searching for another big idea to make money. They think they may have found one.

The bankers plan to buy “life settlements,” life insurance policies that ill and elderly people sell for cash — $400,000 for a $1 million policy, say, depending on the life expectancy of the insured person. Then they plan to “securitize” these policies, in Wall Street jargon, by packaging hundreds or thousands together into bonds. They will then resell those bonds to investors, like big pension funds, who will receive the payouts when people with the insurance die.

The earlier the policyholder dies, the bigger the return — though if people live longer than expected, investors could get poor returns or even lose money.

Either way, Wall Street would profit by pocketing sizable fees for creating the bonds, reselling them and subsequently trading them. But some who have studied life settlements warn that insurers might have to raise premiums in the short term if they end up having to pay out more death claims than they had anticipated.

The idea is still in the planning stages. But already “our phones have been ringing off the hook with inquiries,” says Kathleen Tillwitz, a senior vice president at DBRS, which gives risk ratings to investments and is reviewing nine proposals for life-insurance securitizations from private investors and financial firms, including Credit Suisse [and Golman Sachs].

“We’re hoping to get a herd stampeding after the first offering,” said one investment banker not authorized to speak to the news media.. . . .

. . . .In early 2008, the firm [DBRS] published criteria for ways to securitize a life settlements portfolio so that the risks were minimized.

Interest poured in. Hedge funds that have acquired life settlements, for example, are keen to buy and sell policies more easily, so they can cash out both on investments that are losing money and on ones that are profitable. Wall Street banks, beaten down by the financial crisis, are looking to get their securitization machines humming again.

Ms. Tillwitz, an executive overseeing the project for DBRS, said the firm spent nine months getting comfortable with the myriad risks associated with rating a pool of life settlements.

Could a way be found to protect against possible fraud by agents buying insurance policies and reselling them — to avoid problems like those in the subprime mortgage market, where some brokers made fraudulent loans that ended up in packages of securities sold to investors? How could investors be assured that the policies were legitimately acquired, so that the payouts would not be disputed when the original policyholder died?

And how could they make sure that policies being bought were legally sellable, given that some states prohibit the sale of policies until they have been in force two to five years?

Spreading the Risk

To help understand how to manage these risks, Ms. Tillwitz and her colleague Jan Buckler — a mathematics whiz with a Ph.D. in nuclear engineering — traveled the world visiting firms that handle life settlements. “We do not want to rate a deal that blows up,” Ms. Tillwitz said.

The solution? A bond made up of life settlements would ideally have policies from people with a range of diseases — leukemia, lung cancer, heart disease, breast cancer, diabetes, Alzheimer’s. That is because if too many people with leukemia are in the securitization portfolio, and a cure is developed, the value of the bond would plummet.. . . .

And so a generation hence, the biggest casinos of Wall Street may be positioned, once more, to make a killing, so to speak, from the continued deterioration of life and early deaths in a place once known as America.

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E.J. McMahon, director at the Manhattan Institute says New York deficits amount to financial emergency.

New York state's huge and growing budget gap requires government to take drastic actions to correct it, said E.J. McMahon, director of the Empire Center for New York State Policy at the Manhattan Institute.

McMahon spoke to the Council of Industry, a regional trade group, Friday at the Powelton Club.

He charted flat revenues against expected spending if nothing is changed and showed a $20 billion gap looming by 2012-13.

McMahon said the state must declare a financial emergency and enact a statutory freeze on public-sector wages for at least three years. State law allows this and enables contracts to be voided, he said. It would save at the rate of $2 billion a year for state, local and school taxpayers.

McMahon also called for shutting down the state's pension systems to new entrants and giving them instead a plan similar to one of the alternatives for the State University system, in which a stable amount is contributed by the state and employees can add their own.

He said some parts of the state's Taylor Law, governing labor relations with public employees, should be repealed, including compulsory arbitration for police and fire unions. Other laws should also be targeted for repeal because they're costly, including the rule requiring that on most public work the "prevailing wage" be paid, usually the union scale.

State spending should be capped by changing the state constitution, he said, recommending the "tax expenditure limitation" approach exemplified by Colorado.

He laid blame on politicians.

"It's their failure to stop the growth in spending that is the underlying problem," he said. "New Yorkers are voting with their feet and heading for the exits."